European stock markets fell back on Wednesday and shares in Madrid plunged as investors kept a watchful eye on Spain and Italy after sharp gains the previous day.

At the close, London's benchmark FTSE 100 index was down 0.38 per cent at 5745.29 points, Frankfurt's DAX 30 slumped 1.01 per cent to 6732.03 points and in Paris the CAC 40 tumbled 1.59 per cent to 3240.29 points.

Madrid's benchmark IBEX 35 lost a sharp 3.99 per cent after figures showed an spike in bad loans at Spanish banks and Milan's FTSE Mib index sank 1.71 per cent after the government downgraded its growth forecasts, putting off the 2013 target for a balanced budget.

In foreign exchange trade, the euro dropped to $1.3111 from $1.3125 in New York late Tuesday and the dollar rose to 81.26 yen from 80.88 yen.

In the US, investors put aside some solid earnings and sold down US stocks.

The Dow Jones Industrial Average was down 0.44 per cent, the broader S&P 500 lost 0.26 per cent while the Nasdaq fell up 0.47 per cent at around 1600 GMT.

European stocks soared on Tuesday after a successful Spanish bond auction eased concerns over the eurozone debt crisis, with further support coming from an upbeat IMF outlook on the world economy.

However, markets retreated on Wednesday after Italy slashed its 2012 economic growth outlook to minus 1.2 per cent from minus 0.4 per cent and said it will miss a 2013 target for a balanced budget as officials struggle to revive the economy.

Prime Minister Mario Monti had initially vowed to uphold the previous government's pledge to balance its budget in 2013 and the technocrat government has now raised the 2013 deficit target from 0.1 per cent of Gross Domestic Product to 0.5 per cent.

The news did little to assuage investor worries that Italy and Spain could fall victim to the long-running eurozone sovereign debt crisis, dealers said.

From beginning of session, "the banking sector was under pressure the day before a crucial debt auction for Spain," Guillaume Garabedian, analyst with Meeschaert Gestion Privee said.

Sentiment on lenders took a blow from official data showing that Spanish bank's bad loans hit an 18-year high in February, as lenders struggled with a mass of deteriorating property-related loans.

Doubtful loans in February amounted to 143.8 billion euros ($A182.50 billion), rising to 8.15 per cent of total credit - the highest ratio since 1994 - from 7.91 per cent in January, the Bank of Spain said.

A loan is categorised as doubtful when the borrower has not made a payment for at least three months.

"Spanish markets are being affected by fears about loan write-downs Spanish banks will have to bear as property prices in the country continue to fall," CMC Markets analyst Michael Hewson told AFP.

"These non-performing loans have climbed to their highest levels since 1994 and will increase substantially the cost of cleaning up the Spanish banking sector.

"With unemployment rising this is unlikely to improve and the ... bond auction will be a key test of investors faith in Spain's ability to overcome its problems in the face of fiscal austerity and a contracting economy."

Investors were also helped by the International Monetary Fund, which said in its semi-annual global forecast that the world economy would grow 3.5 per cent this year and 4.1 per cent in 2013, up from its earlier projections of 3.3 per cent and 4.0 per cent.